Patient Power The Cato Institute'sPlan For Health Care Reform

by Brink Lindsey

Brink Lindsey is director of regulatory studies at the Cato Institute.

Executive Summary

The crisis of soaring health care costs has one funda
mental cause: people are usually spending someone else's
money when they purchase health care services. The rise of
third-party payment has created an incentive structure that
makes runaway spending inevitable. Health insurance is now
the equivalent of auto insurance that covers fill-ups and
oil changes.

The Cato Institute's Patient Power plan for health care
reform seeks to put control over spending back in the hands
of individual patients. Under the Patient Power plan,
people could make deposits to tax-free Medical Savings
Accounts to finance routine medical expenses. Workers cur
rently covered by employer-provided insurance could fund
their MSAs by switching from low-deductible policies to
high-deductible catastrophic policies and depositing the
premium savings. Furthermore, the Patient Power plan would
eliminate the arbitrary discrimination of today's tax system
and allow all Americans, regardless of employment status, to
claim tax benefits for purchasing catastrophic insurance and
making deposits to Medical Savings Accounts.

Introduction

Our present health care system is suffering from run-away prices and spending. For the past three decades,
health care spending has been growing more than twice as
fast as the overall economy; as a percentage of gross na tional product, it has risen from 6 percent in 1965 to 14
percent today. Meanwhile, the system is plagued not only by
overspending, but also by underinclusion: at any given time
about 35 million Americans do not have health insurance.
That combination of ills appears to pose an intractable
problem: any move to extend health insurance in its current
form to those without coverage will only fuel demand for
health care and push spending up even further.

Fortunately, there is a solution to the predicament.
The key is recognizing exactly what is driving spending
through the roof. While many conditions have contributed to
the spending explosion, one stands out as the fundamental
problem with the U.S. health care system today: the consumer, the patient, has been cut out of the decisionmaking
loop. Of every health care dollar spent in this country, 76
cents are paid by someone other than the actual patient--by
the government, insurers, or employers. Consequently, in
most situations patients neither benefit when they spend
wisely nor bear the consequences of spending foolishly.
With those incentives, it is no surprise that costs are
soaring.

To reform the system we need to change the incentives.
We need policies that will allow people to choose whether
and how to spend their own money on health care needs. That
is the idea behind the Cato Institute's Patient Power plan.
The plan is explained in detail in Patient Power: Solving
America's Health Care Crisis by John C. Goodman, president
of the National Center for Policy Analysis, and Gerald L.
Musgrave, president of Economics America, Inc.(1)

Under the Patient Power plan, people would be able to
switch from their current low-deductible health insurance
policies to high-deductible catastrophic policies and put
the premium savings in tax-free Medical Savings Accounts
(MSAs). Those accounts would be used to pay ordinary and
routine medical expenses, and catastrophic insurance would
still be available to cover any major expenses. Whatever
money was left in MSAs at the end of the year would remain
there and continue to earn interest--you would get to keep
what you did not spend.

The Patient Power plan would give people a direct
financial incentive to spend prudently on health care,
because they would be spending their own money. Furthermore, Patient Power would extend the same tax advantages to
all Americans, unlike the current system that discriminates
against the unemployed, the self-employed, and employees of
small businesses that do not offer health insurance. Ensuring tax fairness would go a long way toward making health
care affordable for people who are now without health insurance.

The Patient Power plan is explicitly voluntary: it is
not designed to compel universal coverage under some one-
size-fits-all arrangement. The most basic element of a
truly competitive health care system is to allow people the
freedom of opting out of it--true Patient Power begins with
that fundamental freedom of choice. Accordingly, the Patient Power plan strives to expand options, not foreclose
them--to let people make up their own minds about what works
best for them.

The Rise of Third-Party Payment

Before 1965 spending on health care was restrained by
the fact that most payments were made out-of-pocket by
patients. Since then Medicare and Medicaid have expanded
government third-party insurance to more and more services
for the elderly and the poor, and private health insurance
has expanded for the working population. As Figure 1 shows,
95 percent of the money Americans now spend on hospitals is
someone else's money at the time it is spent. Some 81
percent of all physicians' payments are now made with other
people's money, as are 76 percent of all medical payments
for all purposes.

Third-party payment is now so dominant that the term
health insurance has become a misnomer. True insurance is
supposed to protect people against losses from rare high-
cost events. Today's health insurance, however, covers all
kinds of routine expenses that are entirely under the patient's control; such coverage is less insurance than pre-payment of medical services. Auto insurance does not cover
fill-ups and oil changes, but today's health insurance
covers the equivalent.

As a result of the dramatic rise of third-party pay-
ment, the consumers of health care, the patients, no longer
have much incentive to spend money wisely. When people pay
only five cents on the dollar for hospitalization, they are
unlikely to be very prudent consumers, and hospitals are
under little pressure to offer good deals. Elementary
economics teaches that as prices go down, demand increases,
and the recent history of the U.S. health care system con-
firms that basic truth. Because of third-party payment,
health care has become nearly free at the point of sale,
triggering an explosion in spending.

Putting Patients Back in Control

The health care reform proposals favored by the Clinton
administration do nothing to address the third-party payment
problem that is the root of the health care crisis. In
fact, the administration's plan for "managed competition"
would worsen the problem by creating a new third-party
payment system that would be universal in coverage. To try
to keep costs down, managed competition would impose onerous
new bureaucratic controls and limitations on patients'
choices.

Not only would managed competition fail to control
costs, it would also pose a serious threat to the continued
quality of American medical care. Managed competition means
greater bureaucratic rationing of health care--whether
openly through price controls and expenditure limits (so-
called global budgets) or less obviously through increased
third-party control over what services are paid for. But
whatever form it takes, bureaucratic rationing means lower
quality care. Just look at what has happened in countries
where government controls the health care purse strings. In
Britain kidney dialysis is generally denied to patients
older than 55, causing at least 1,500 people to die every
year for lack of dialysis. In Sweden the wait for heart
x-rays is more than 11 months. And surgeons in Canada
report that, for patients in need of heart surgery, the
danger of dying on the waiting list now exceeds the danger
of dying on the operating table.

The Cato Institute's Patient Power plan rejects the
bureaucratic approach of managed competition. Combatting
artificially stimulated demand with top-down bureaucratic
interference is a multiplication of mistakes. The result is
higher costs and lower quality care. What we need instead
is a system that controls demand at the source: the individual patient. The way to get individual patients to control
demand is to give them a financial incentive to do so.

Supplying that financial incentive is what the Patient
Power proposal for Medical Savings Accounts is all about.
Under the Patient Power plan, people would be able to deposit up to a certain amount of money every year in tax-free
MSAs. Most people would fund their accounts by switching
from their current low-deductible health insurance policies
to high-deductible catastrophic policies and depositing the
premium savings. They would then be able to draw down their
account balances to pay ordinary, routine medical expenses,
such as doctor's office visits, prescription drugs, diagnostic tests, and minor procedures. Catastrophic insurance
would still cover the big-ticket items.

Whatever money you did not spend during the year would
remain in your MSA to build up tax-free interest over time.
Most people would be able to accumulate substantial savings
over their working lives, which they could use upon retire-
ment for whatever medical or nonmedical purpose they chose.
Patient Power is thus diametrically opposed to the Clinton
administration's managed-competition approach. Managed
competition seeks to reform the health care system by adding
new layers of bureaucratic control and further restricting
consumer choice. Patient Power does just the opposite: it
seeks to strip away third-party-payment bureaucracy and
expand consumer choice. That is why the Cato Institute
calls its proposal Patient Power: the goal is to empower
patients, not bureaucrats.

How Medical Savings Accounts Would Work
Figure 2 gives an indication of how Patient Power would
operate in practice. In a city that has an average cost of
living--say Cincinnati or Denver--employers pay roughly
$4,500 a year to provide an employee and his family with
health insurance coverage. The policy has a low deductible,
typically from $100 to $250. By contrast, the premium for a
catastrophic policy with a $3,000 deductible is only about
$1,500 a year. Under the Patient Power plan, an employer
could provide a catastrophic policy and then put the $3,000
in premium savings in the employee's MSA. The employer is
out $4,500 either way; it makes no difference to him how the
money is split up. But for the employee, the advantages of
the switch are enormous: he actually gets more money in cash
(tax-free, interest-bearing cash) than he loses in reduced
insurance coverage--even during the first year. Over time,
unused savings continue to build up with tax-free compound
interest.
The vast majority of Americans would greatly benefit
from the combination of less expensive high-deductible
policies and Medical Savings Accounts. In any given year
most Americans have no or very small medical expenses, and
Figure 2
Typical Health Insurance Costs in a City with
Average Cost of Living
[Bar Graph Omitted]
Current Low-Deductible System:
Cost of Insurance to Employer - $4,500
Patient Power Plan (Catastophic Insurance plus MSA's):
Cost of Insurance to Employer - $1,500
Premium Savings for MSA Deposit - $3,000
Source: Golden Rule Insurance Company.
94 percent have medical expenses under $3,000. Under such
asystem, your maximum personal exposure every year is capped
by your catastrophic policy; meanwhile, your savings to meet
that possible exposure keep accumulating every year with
interest. In other words, the deck is stacked in favor of
your coming out ahead.
Medical Savings Accounts would be of particular help to
employees and their families when money was tight. Even
today's low deductibles, particularly when combined with
copayments, can create true hardship for those struggling to
make ends meet. With MSAs, money would be available to pay
the first dollar of medical costs--no deductibles, no co-
payments. In addition, people who were between jobs could
use their MSAs to buy insurance coverage. About half the
people who are uninsured remain that way for four months or
less; typically, they are between jobs that provide them
with health insurance benefits. The accumulated savings in
Medical Savings Accounts would be available to tide people
over during such times.
Establishing Tax Fairness
If Medical Savings Accounts are as great as they sound,
why have employers not made them available already? Why do
employers not offer high-deductible policies and cash bo-
nuses as an alternative to conventional low-deductible
insurance?
The reason such arrangements are currently unattractive
is that under existing tax laws, only the employer's spend-
ing on health care is fully tax-deductible. Today, all the
money an employer spends on health insurance for employees
is tax-deductible; furthermore, none of it is included in
the employee's taxable income. By contrast, self-employed
people can deduct, at best, only 25 percent of their health
insurance expenses--and even that limited deduction is not a
permanent part of the law; it is on-again, off-again from
year to year depending on whether Congress reauthorizes it.
And the unemployed and employees of small businesses that do
not offer health insurance get no deduction at all when they
try to purchase insurance on their own.
Thus, under current law, employers spend pretax dollars
on health care; everyone else is forced to spend (for the
most part) posttax dollars. The tax bias in favor of em-
ployer-provided health insurance is considerable. As Table
1 indicates, a dollar of pretax health insurance benefits
can be worth almost two dollars of taxable salary. Accord-
ingly, once filtered through the various tax collectors, the
Table 1
Relative Value of a Dollar of Employer-Provided
Health Insurance Benefits
Federal Tax Value with No State Value with State
Category[1] and Local Income Tax and Local Income Tax
FICA tax only $1.18 $1.24[2]
FICA tax plus $1.43 $1.57[3]
15% income tax
FICA tax plus $1.76 $1.97[3]
28% income tax
[1] Includes employer's share of FICA taxes.
[2] State and local income tax rate equals 4 percent.
[3] State and local income tax rate equals 6 percent.
Source: Patient Power, Table 9.2, p. 266
premium savings from switching to a high-deductible policy
would shrink as much as 50 percent if they were given as
cash to employees. And if employees tried to establish
their own make-do Medical Savings Accounts with that posttax
money, they would also have to pay taxes on the interest
they earned. It is little wonder that employers and employ-
ees opt for the tax-favored benefit over the tax-discouraged
one.
It should be noted that under the current system, some
people covered by employer-provided insurance are able to
earmark money to go into so-called flexible savings ac-
counts, from which they can pay health expenses with pretax
dollars. The problem with flexible spending accounts is
that at the end of the year, any unspent money reverts to
the employer. That "use it or lose it" approach obviously
encourages wasteful spending--the opposite of what Medical
Savings Accounts would do.
The bias in the tax system not only discourages self-
insurance through medical savings, it also renders conven-
tional health insurance unaffordable for many Americans.
The self-employed, the unemployed, and employees of many
small businesses must pay posttax dollars for their health
insurance, and not surprisingly they rarely do. About 90
percent of Americans who have private health insurance get
it through their employers. Those not lucky enough to
qualify for tax advantages through their employers must
fendfor themselves, and their numbers swell the ranks of the
35 million uninsured.
The present indefensible system came about, strangely
enough, because of wage and price controls during World War
II. Businesses tried to get around wage freezes by offering
health insurance benefits to their employees. The Internal
Revenue Service went along, granting them a tax deduction
and excluding the fringe benefit from employees' income.
The law of unintended consequences frequently haunts govern-
mental intervention, and here is a textbook case. Thanks to
wartime emergency measures taken 50 years ago, we now have a
health insurance system in double crisis, plagued by both
explosive overspending and underinclusiveness caused by
discriminatory tax rules.
What we must do, and what the Patient Power plan pro-
poses, is to end the current discriminatory tax treatment of
health care spending and establish tax fairness for all
Americans. That goal could be accomplished in one of two
ways. Individuals not covered by employer-provided insur-
ance could be granted the same tax deduction that employers
are allowed to take. Or, alternatively, employer-provided
health insurance could be included in the taxable income of
employees, and then all Americans could be granted individu-
al tax credits for health care expenses.
Whatever form the tax incentive takes, it should be
structured to allow a direct tradeoff between lower deduct-
ible third-party health insurance and self-insurance through
depositing money in a Medical Savings Account. For example,
the deduction or credit could be tied to the average cost of
a low-deductible policy. The higher the deductibles of the
policies people chose, the lower their premiums would be,
and thus the more money (up to a certain limit, say $3,000 a
year) they could deposit in tax-free MSAs. Such an arrange-
ment would allow individuals to choose the mix they pre-
ferred of third-party insurance and personal savings.
Cost Savings through Patient Power
The Patient Power plan of Medical Savings Accounts and
tax fairness would revolutionize the incentives operating in
the health care sector. Roughly two-thirds of all health-
insurance-claim dollars in this country fall in the under-
$3,000-per-year category. Under the Patient Power plan,
people would be spending their own money in this dominant
sector of the health care market.
Because they could keep what they did not spend, people
would have an incentive to spend wisely for health care. A
RAND Corporation study found that people enjoying free
health care spend about 50 percent more than those who pay
95 percent of their bills out-of-pocket (up to a $1,000
maximum).(2) Furthermore, people with free care are 25 per-
cent more likely to see a doctor and 33 percent more likely
to enter a hospital. All that extra spending of other
people's money, though, does not necessarily buy better
results: the RAND study found no apparent differences in
most health outcomes for the two groups.
It is important to realize that given the current state
of medical technology, the amounts we could spend on health
care are potentially limitless. We could probably spend
half our gross national product on diagnostic tests alone.
There are currently some 900 different blood tests that can
be performed. Why not make all 900 part of an annual check-
up? And consider what would happen if every person who
chooses to medicate himself with nonprescription drugs
decided instead to go to the doctor. To handle the explo-
sion in demand, we would need 25 times the current number of
primary care physicians.
Given that the demand for medical services is poten-
tially infinite, health care spending must be limited one
way or another. And normally, he who pays the piper gets to
call the tune. Thus, under the current system, health care
is increasingly rationed by the third-party payers--insur-
ance companies and government bureaucrats. Their control
over who gets what--up to and including who lives and who
dies--would increase dramatically under managed competition.
Patient Power offers the only viable alternative to bureau-
cratic rationing: individual choice, with people making
their own personal tradeoffs between medical services and
other needs.
With people spending their own money on health care,
doctors, hospitals, and other service providers would be
forced to compete on price, quality, and convenience to
attract patients. Currently, such competition is stifled
because, by and large, patients are not the real paying
customers--government and insurers are. Accordingly, the
"prices" on medical bills are not really market prices at
all; they are simply a means of passing along costs to
third-party payers. And information on quality--for exam-
ple, mortality rates at hospitals--is not normally made
available to patients.
By contrast, competition has been vigorous in those
exceptional areas of the health care sector where third-
party payment does not dominate. Consider cosmetic surgery,
which is not covered by any private or public insurance
policy. Patients pay with their own money, and they are
treated accordingly. They are generally quoted a fixed
price in advance, covering both medical services and hospi-
tal charges. They are given choices about the level of
service (for example, surgery performed at the doctor's
office or, for a higher price, on an outpatient basis at a
hospital). For another example, consider America's $12-
billion eye care industry, in which costs have been holding
steady or even falling in recent years. The simple reason:
unregulated price competition.
By eliminating the third-party paper shuffling associ-
ated with small-dollar-amount expenditures, Patient Power
would dramatically reduce administrative costs. Such costs
today are unusually high (the cost of marketing and adminis-
tering private health insurance runs between 11 and 12
percent of premiums) because of the enormous number of small
claims that unnecessarily clog the present system. The cost
of processing many small claims actually exceeds the amount
of the claims. By converting to high-deductible policies
and letting people pay routine expenses directly out of
their Medical Savings Accounts, all that excessive paperwork
would be eliminated.
Enormous cost savings could be achieved if the combina-
tion of catastrophic insurance and Medical Savings Accounts
were extended universally (including replacing Medicare and
Medicaid). Total administrative savings are estimated
(based on 1990 figures) to be as high as $33 billion a year;
in addition, more prudent spending by patients would produce
savings of up to an estimated $147 billion a year. After
factoring in extra costs of $12 billion a year due to insti-
tuting tax fairness, net total cost savings come to $168
billion--or nearly one-fourth of total annual health care
spending in this country. And that rough estimate does not
include the savings gained from lower prices that would
surely be a major benefit of the new competitive health care
marketplace that Patient Power would help bring about.
Conclusion
The Cato Institute's Patient Power plan to reform
health insurance has three main elements:
1. allow people to make deposits in tax-free Medical
Savings Accounts to finance their routine medical expenses;
2. allow people currently receiving employer-provided
insurance to fund their Medical Savings Accounts by switch-
ing from low-deductible policies to high-deductible cata-
strophic policies with much lower premiums; and
3. allow all Americans, regardless of whether they
receive employer-provided insurance, to claim tax benefits
(whether in the form of deductions or credits) for purchas-
ing catastrophic health insurance and making deposits in
Medical Savings Accounts.
Notice the key word repeated in all three elements of
the Patient Power plan: allow. The plan is voluntary; it
does not force anyone to do anything. The purpose of Pa-
tient Power is to expand people's choices, not narrow them--
to enable people to make their own decisions about tradeoffs
between health care and other needs, not to create yet
another bureaucracy to make those decisions for us.
Only by empowering patients can we tap the power of
market incentives to transform our bloated, bureaucratized
health care system. So-called reform packages based on
further restricting patient choice move in precisely the
wrong direction; not only would they be unable to control
costs effectively, but they would also imperil the high
quality of medical care that Americans currently enjoy.
Managed competition is not the answer. Real competition is.
The Patient Power plan, by enabling people to spend their
own money on medical needs, would inject a whopping dose of
real competition into our ailing health care system.
Twenty Questions and Answers about Medical Savings Accounts
1. How would Medical Savings Accounts be administered?(3)
MSAs would be administered by qualified financial
institutions in much the same way individual retirement
accounts (IRAs) are.
2. How would funds from Medical Savings Accounts be spent?
The simplest method would be by debit card. Patients
would use their debit cards to pay for medical services at
the time they were rendered. At the end of each month,
account holders' statements would show recent expenses and
account balances. No more paperwork would be needed than
with any other credit card.
3. What would prevent fraud and abuse?
To receive MSA funds, a provider of medical services
would have to be qualified under IRS rules. Qualifying
should be a simple procedure, involving little more than
filing a one-page form. If IRS auditors discovered fraudu-
lent behavior, the provider would lose the right to receive
MSA funds and would be subject to criminal penalties.
4. What types of services could be purchased with MSA funds?
Any type of expense considered a medical expense under
current IRS rules would qualify. In general, the IRS has
been fairly broad in its interpretation of what constitutes
a medical expense. An unhealthy step in the wrong direc-
tion, however, was the IRS decision to disallow cosmetic
surgery. There is no apparent reason why the removal of a
disfiguring scar or a change in facial appearance that
improves employability and self-esteem is any less important
than an orthopedic operation that allows an individual to
play a better game of tennis or polo.
5. What tax advantages would be created for Medical Savings
Account deposits?
MSA deposits would receive the same tax treatment as
health insurance premiums. Thus, under employer-provided
health insurance plans, MSA deposits would escape federal
income taxes, Social Security taxes, and state and local
income taxes. If the opportunity to receive a tax deduction
or a tax credit for the purchase of health insurance were
extended to individuals, their deposits to Medical Savings
Accounts would receive the same tax treatment. MSA balances
would grow tax-free and would never be taxed if the funds
were used to pay for medical care or purchase long-term care
or insurance to cover long-term care.
6. What about low-income families who cannot afford to make
Medical Savings Account deposits?
If low-income families can afford to buy health insur-
ance, they can afford to make MSA deposits, since the prima-
ry purpose of the MSA option is to enable individuals to
divide their normal health insurance costs into two parts:
self-insurance and third-party insurance. Currently, little
or no tax advantage is available for people who purchase
health insurance on their own. Health insurance would
become more affordable for the currently uninsured if they
could deduct the premiums from their taxable income. A
system of refundable tax credits, which would grant greater
tax relief to low-income people, would make insurance even
more affordable.
7. How could individuals build up funds in their MSA ac-
counts?
One way would be to choose a higher deductible insur-
ance policy and deposit the premium savings in an MSA. For
most people, a year or two of such deposits would exceed the
amount of their insurance deductible. An alternative (which
tends to be revenue neutral for the federal government)
would be to permit people to reduce the amount of their
annual, tax-deductible contributions to IRAs, 401(k) plans,
and other pensions and deposit the difference in Medical
Savings Accounts.
8. What if medical expenses not covered by health insurance
exceed the balance in an individual's Medical Savings Ac-
count?
One solution would be to establish lines of credit
(either with employers or with the financial firms that
managed MSAs) so that individuals could effectively borrow
to pay medical expenses. Repayment would be made with
future MSA deposits or other personal funds. Another solu-
tion would be to permit family members to share their MSA
funds. This concern would vanish as MSA balances grew over
time.
9. How would members of the same family manage their MSA ac-
counts?
Because family members often are covered under the same
health insurance policy, it seems desirable to permit cou-
ples to own joint MSA accounts and for parents to own family
MSA accounts. In those cases, more than one person could
spend from a single account. But even if family members
maintained separate accounts, that should not preclude the
pooling of family resources to pay medical bills.
10. What about people who are already sick and have large
medical obligations at the time the plan is started?
Such people might be harmed by a sudden increase in the
health insurance deductible unless transitional arrangements
were made. Most would benefit from a high deductible in the
long run, but they might suffer financially at the outset.
One solution is the use of credit lines that can be repaid
from future MSA contributions.
11. What about people who have a catastrophic illness with
large annual medical bills likely to last indefinitely into
the future?
Most of those people would be disadvantaged if they had
an annual deductible. A better form of health insurance
would be one with a per-condition deductible, which would be
paid only once for an extended illness.
12. Are there circumstances under which individuals could
withdraw MSA funds for nonmedical expenses before retire-
ment?
A reasonable policy is to apply the same rules that now
apply to tax-deferred savings plans (for example, IRAs and
401(k) plans). Thus, withdrawals for nonmedical purposes
would be fully taxed and would face an additional 10 percent
tax penalty.
13. How do we know people would not forgo needed medical
care (including preventive care) in order to conserve their
MSA funds?
We don't. The theory behind Medical Savings Accounts
is that people should have a store of personal funds with
which to purchase medical care. And because the money they
spend would be their own, they would have strong incentives
to make prudent decisions. Undoubtedly, some of their
decisions would be wrong. But many decisions made under the
current system are also wrong. Under the new system people
would at least have funds on hand with which to pay their
share of medical bills. And since people would have an
incentive to protect future account balances to cover future
medical costs, some would certainly spend more on preventive
health care. Because we cannot spend our entire GNP on
health, health care has to be limited in some way. The only
alternative to government rationing, with decisions made by
a health care bureaucracy, is individual choice, with people
making their own tradeoffs between medical services and
other needs.
14. Given the increasing complexity of medical science, how
could individuals possibly make wise decisions when spending
their MSA funds?
One thing people can do is solicit advice from others
who have superior knowledge. For example, most large em-
ployers and practically all insurance companies have cost-
management programs in which teams of experts make judgments
about whether, when, and where medical procedures will be
performed. Those experienced professionals could play an
important role in helping patients make decisions about
complicated and expensive procedures. Also, telephone
advisory services, which are springing up around the coun-
try, could well become an important source of expert infor-
mation in the coming years. In any event, we should let the
experts advise and the patient decide.
15. Given the problems that major employers and insurance
companies have in negotiating with hospitals, how could
individual patients possibly do better?
The reason large institutions have so much difficulty
negotiating with hospitals is that institutions are not
patients. And the reason patients who spent their own money
would wield effective power is the same reason consumers
wield power in every market--they can take their money and
go elsewhere. Physicians, hospitals, and other health care
providers would have considerable incentive to win their
business. Moreover, Medical Savings Accounts would not
preclude individuals from using employers as bargaining
agents.
16. What would happen to Medical Savings Account balances at
retirement?
People should be able to roll over their MSA funds into
an IRA or some other pension fund. Thus, money not spent on
medical care could be used, after taxes, to purchase other
goods and services, including postretirement health care and
insurance coverage for long-term care.
17. What would prevent wealthy individuals from misusing
Medical Savings Accounts to shelter large amounts of tax-
deferred income?
An individual's total tax-advantaged expense for health
insurance plus MSA deposits could not exceed a reasonable
amount. One definition of "reasonable" would be an annual
MSA deposit that would equal the deductible for a standard
catastrophic health insurance policy.
18. What about members of HMOs?
They would have the same opportunities as people cov-
ered by conventional, fee-for-service health insurance
plans. Note that because many HMOs are now instituting
copayments, HMO members would have incentives to acquire
Medical Savings Accounts. Their HMO premiums plus their MSA
deposits could not exceed a reasonable amount, however.
19. Under employer-provided plans, would employees have a
choice of deductibles?
Permitting employees to make individual choices makes
sense. Over time, different people would have different
accumulations in their MSAs and, quite likely, different
preferences about health insurance deductibles. According-
ly, employers would have an incentive to provide a range of
benefit plans to suit different employee needs.
20. What would happen to flexible spending accounts now
available to some employees?
Medical Savings Accounts would replace FSAs under
employee benefits law. Currently, employees who make depos-
its to FSAs must use the money or lose it, typically within
12 months. Similar deposits made to Medical Savings Ac-
counts would have no such restrictions.
Ten Advantages of Medical Savings Accounts
1. The cost of health insurance would be lower.(4)
MSAs would allow people to substitute less costly self-
insurance for more costly third-party insurance for small
medical bills. To the degree they were self-insured, people
would no longer face premium increases caused by the waste-
ful consumption decisions of others. And to the extent that
third-party insurance was reserved for truly risky, cata-
strophic events, the cost per dollar of coverage would be
much lower than it is today.
2. The administrative costs of health care would be lower.
Because we rely on third parties to pay a large part of
almost every medical bill, unnecessary and burdensome paper-
work is created for doctors, hospital administrators, and
insurers. By one estimate, as much as $33 billion a year in
administrative costs could be saved by the general use of
Medical Savings Accounts.
3. The cost of health care would be lower.
Medical Savings Accounts would institute the only cost-
control program that has ever worked: patients' avoiding
waste because they have a financial incentive to do so.
When people spent money from their MSAs, they would be
spending their own money, not someone else's--an excellent
incentive to buy prudently. By one estimate, the general
use of Medical Savings Accounts would reduce total health
care spending by almost one-fourth.
4. Financial barriers to purchasing health care would be
removed.
Under the current system, employers are responding to
rising costs of health insurance by increasing employee
deductibles and copayments. Market prices are also encour-
aging people who buy their own health insurance to opt for
high deductibles and copayments. One problem with that
trend is that people with low incomes who live from paycheck
to paycheck may forgo medical care because they cannot pay
their share of the bill. Medical Savings Accounts would
ensure that funds were available when people needed them.
5. Financial barriers to purchasing health insurance during
periods of unemployment would be removed.
Under current law, people who leave an employer who
provided their health insurance are entitled to pay the
premiums and extend their coverage for 18 months. Yet the
unemployed are the people least likely to be able to afford
those premiums. Medical Savings Accounts would solve that
problem by providing funds that were separate from those
available for ordinary living expenses. MSA funds might
also be used to purchase between-school-and-work policies or
between-job policies of the types already marketed.
6. The doctor-patient relationship would be restored.
Medical Savings Accounts would give individuals direct
control over their health care dollars, thereby freeing them
from the arbitrary, bureaucratic constraints often imposed
by third-party insurers. Physicians would view patients
rather than third-party payers as the principal buyers of
health care services and would be more likely to act as
agents for their patients rather than for an institutional
bureaucracy.
7. We would enjoy the advantages of a competitive medical
marketplace.
Patients who enter hospitals can neither obtain a price
in advance nor understand the charges afterward. Those
problems have been created by our system of third-party
payment and are not natural phenomena of the marketplace.
When patients pay with their own money (as is the case for
cosmetic surgery in the United States and most routine
surgery at private hospitals in Britain), they usually get a
package price in advance and can engage in comparison shop-
ping.
8. We would enjoy the advantages of real health insurance.
Because health insurance today is largely prepayment
for consumption of medical care, people with preexisting
health problems often cannot buy insurance to cover other
health risks. Medical Savings Accounts would encourage a
market for genuine catastrophic health insurance and would
make such insurance available to more people.
9. Incentives for better choices of lifestyle would be
created.
Because MSAs would last people's entire lives, they
would allow individuals to engage in lifetime planning and
act on the knowledge that health and medical expenses are
related to their choices about lifestyle. People would bear
more of the costs of their bad decisions and reap more of
the benefits of their good ones. Those who did not smoke,
ate and drank in moderation, refrained from drug use, and
otherwise engaged in safe conduct would realize greater
financial rewards for their behavior.
10. Health insurance options during retirement would be
expanded.
Most Medical Savings Accounts would eventually become
an important source of funds with which to purchase health
insurance or make direct payments for medical expenses
during retirement. Such funds would help solve the growing
problem of long-term care for the elderly.
Notes
(1) John C. Goodman and Gerald L. Musgrave, Patient Power:
Solving America's Health Care Crisis (Washington: Cato
Institute, 1992).
(2) Robert Brook et al., The Effect of Coinsurance on the
Health of Adults (Santa Monica, Calif.: RAND Corporation,
1984).
(3) This section is taken from Goodman and Musgrave,
pp. 257-61.
(4) This section is taken from Goodman and Musgrave,
pp. 249-51.